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A brilliant testimony that brings a different persepctive on the commodity run.
Testimony of Michael W. Masters
Excerpts:
"Are Institutional Investors contribuing to food and energy price inflation?" Any my unequivocal answer is "YES". In this testimony I will explain that institutional investors are one of, if not the primary, factors affecting commodities prices today.
In the popular press the explanation given most often for rising oil prices is the increased demand for oil from China. (Over the last five years) The increase in demand from Index Speculators (for petroleum futures) is almost equal to the increase in demand from China!
Assets allocated to commodity index trading strategies have risen from $13 billion at the end of 2003 to $260 billion as of March 2008, and the price of the 25 commodities that compose these indices have risen by an average of 183% in those five years!
Right now, Index Speculators have stockpiled enough corn futures to potentially fuel the entire United States ethanol industry at full capacity for a year.
(...) the current Wheat futures stockpiles of Index Speculators is enough to supply every American citizen with all the bread, pasta and baked goods they can eat for the next years!
Five years ago, Index Speculators were a tiny fraction of the commodities futures markets. Today, in many commodities futures marekts, they are the single largest force. The huge growth in their demand has gone virtually undetected by classically-trained economists who almost never analyze demand in futures markets.
If OPEC supplies the market with more oil, it will have little affect on Index Speculator demand for oil futures. If Americans reduce their demand trough conservation measures like carpooling and using public transportation, it will have little affect in institutional investor demand for commodities futures.
One particularly troubling aspect of Index Speculator demand is that it actually increases the more prices increase.
Rising prices attract more Index Speculators, whose tendency is to increase their allocation as prices rise. So their profit-motivated demand for futures is the inverse of what you would expect from price-sensitive consumer behavior.
There is a crucial distinction between Traditional Speculators and Index Speculators. Traditional Speculators provide liquidity by both buying and selling futures. Index Speculators buy futures and then roll their positions by buying calendar spreads. They never sell. Therefore, they consume liquidity and provide zero benefit to the futures markets.
Index Speculators' trading strategies amount to virtually hearding via the commodities futures markets.
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